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Are you reviewing your portfolio wisely?

Jan 19, 2012

The year gone by...

The Indian equity markets experienced a turbulent time in the year 2011 steered by series of events. First it was the MENA (Middle East and North Africa)region which faced a geopolitical crisis, and then it was Japan who encountered a natural calamity - a Tsunami, which devastated the Fukushima Daiichi Nuclear Power Station and raised concerns of a nuclear crisis as well.

Later while the markets were reeling under these downbeat sentiments of geopolitical and natural crisis (faced by Japan), the economic newsflash started playing a crucial role in paving a path for the markets. The U.S. withdrew its QEII (Quantitative Easing - Round II) initiative; but theend of easy money regime on one end was complemented by near zero interest rates on the other (as the U.S. Federal Reserve decided to keep the interest rates to near zero per cent until March 2013, and also mentioned that chances of QEIII will be evaluated taking into account the economic dynamics going forward).However the increase in the U.S. debt-ceiling limit to U.S. $16.4 trillion, (which had an impact of bloating their debt-to-GDP ratio), encouraged S&P to axe their sovereign ratings to 'AA+' with a negative outlook from 'AAA' earlier enjoyed. The Euro zone too wasn't spared by the rating agencies, as the debt-overhang situation in the Euro zone, along with a dismal economic growth rate encouraged them to axe ratings recently for all Euro nations barring Germany, which still enjoys a prime 'AAA' rating.

The ripples of the global economic and political cues also had a crippling effect on our domestic economy. We too witnessed a slowdown in economic growth rate (as Q2 FY2011-12 expanded by 6.9% - slowest in the last 8 quarters), and industrial activity witnessed a "see-saw" movement. Since headline WPI inflation too remained stubbornly high, the Reserve Bank of India (RBI) took an anti-inflationary stance in its monetary policy action (by increasing policy rates) which too had a denting impact on economic growth due to elevated borrowing cost and input cost.

Health of India's economy

(Source: CSO, PersonalFN Research)

While the Government in power did take reform measures such as increase in FDI (Foreign Direct Investment) limit in multi-brand retail to 51% to provide a fillip to our economy, it was rolled back as the Government succumbed to the pressures from the opposition and failed to strike a balance. Similarly, the Jan Lokpal bill which was put forth in the winter session of the parliament also wasn't passed. Thus there was complete hurly-burly act in the political corridors, which was a reason for policy paralysis.

How did the BSE Sensex performed?

(Base: Rs 100)
(Source: ACE MF, PersonalFN Research)

The chart above reveals that, taking a cue of these confluence of global as well as domestic (economic and political) events, the markets went into a tizzy eroding a quarter (i.e. 25%) of investors' hard savings. Thus say if one were to invest a sum of Rs 100 on December 31, 2010, in the BSE-30 index the same would have fetched a sum of Rs 75 as on December 31, 2011.

The year ahead...

So far, despite the gloomy clouds of a debt-overhang situation in the Euro zone being evident the year 2012 has started quite on a positive note with the BSE Sensex delivering a return of + 6.1%(as on January 17, 2012). But we think that, unless proper austerity measures aren't taken by paining Euro nations, the occurrence of a catastrophic event cannot be ruled out because this is an acute financial crisis which can shake the complete financial system across the world. The fact that barring Germany, all Euro nations have been downgraded reflects that the problem is grave. Moreover, if there isn't a political consensus across all the Euro nations to solve their situation of a debt-overhang, then a political crisis is also evident across the Euro zone. As far as the U.S. is concerned, while their unemployment rate has fallen to 8.5% in December 2011 (from earlier levels of 9.0%), a noteworthy points is that their Quarter-on-Quarter (Q-o-Q) GDP growth rate is appearing dismal. Also, if Fed prints more money to provide a stimulus to economic growth, then a paper driven economy may infuse in long-term problems. As such with the increase in debt-ceiling limit the primary challenge for the U.S. is to trim its debt, and control its debt-to-GDP ratio instead of further increasing its borrowing limits (debt ceiling); because this will merely postpone the crisis, not solve it.

Speaking about India, we think that the Indian equity markets would be watchful of the economic growth rate which we clock going forward. The Q2FY12 economic growth rate has already dwindled to 6.9% since the economy has confronted a high interest rate regime (due to RBI's stance of taming inflation at the cost of economic growth). Going forward, unlesspolicy reforms aren't put in place and corporate earnings numbers don't look very appealing to the streets, the Indian equity market may move sideways for at least the first half of the year, and FII participate may be subdued. WPI inflation numbers too would be watched carefully. Also the hurly-burly act needs to end, to ensure that policy paralysis doesn't occur.

With the gloomy clouds still evident in the global economy, the first half may witness turbulence. And if downbeat economic data is disseminated from across the world - especially Euro zone and the U.S., then the markets may go into a tizzy.

Is it time to review portfolio?

Thus now the question may pop into your mind is - "should I review my portfolio?"

Well, primarily with gloomy clouds still surrounding us, we believe that holding gold into your portfolio will act as insurance against uncertain times. This is because gold has a tendency to get bold when nervous sentiments surround. During such times smart investors prefer to take refuge under the precious yellow metal, which fuels demand and keeps prices high.

While we agree that prices of gold looks elevated, and corrective phases are likely, we think that the corrective phases would be for a short period of time, as gloomy clouds are still evident in the global economy, which would not interrupt the northward secular uptrend of gold.It is noteworthy that in in 1971, the price of gold was about U.S. dollar 32 an ounce and today (i.e. on January 13, 2012) it is U.S. dollar 1,635.5 an ounce - which indicates that price of gold has gone up by 50 times over the last 40 years.In the year gone by too, goldprovided returns of whooping + 38.3% on an absolute basis.

We recommend that you should have a minimum of 5%-10% allocation to gold, and invest in it with a long term perspective with a time horizon of 10 to 20 years.

Talking about your mutual fund investments, with fear of downbeat economic data being disseminated from the Euro zone still remains, staggering your investments would be an appropriate approach. We recommend that you invest in diversified equity funds as this will help reduce risk. However one needs to stay away from U.S. or Euro oriented offshore funds in such a scenario, but instead may look at investing in domestic value style equity funds. Ideally you should opt for the SIP (Systematic Investment Plan) mode of investing as this will help you to manage the volatility of the equity markets well (through rupee-cost averaging) and also provide your investments with the power of compounding.

In the past if you have bought funds getting carried away by persuasive sales pitch given by your distributors / agents / relationship manager, or simply even by the exuberance created by the pink papers and /or glamorous business channels, then a review of your mutual fund portfolio may be required if you are still holding themin your portfolio.This is because very often persuasive sales pitches can be mis-leading, which may result in adding the bad or not so good mutual fund schemes in your portfolio.

While investing it is vital to recognise that it's your hard earned money which you are investing in the markets, and hence probing a little deeper before acting on the fabulous persuasive sales pitch given by your distributors / agents / relationship managers is needed. And if you don't delve deeper, you may be digging your own grave by adding junk or unwanted schemes in your portfolio. Remember, your distributor / agents / relationship managers would make his dough, and you would be adding some junk schemes to your portfolio which may erode wealth for you, rather than create it. Similarly, acting on what your friends, family members, colleagues too is not going to be of any great value to you.

And while most of you may arrogantly say, "So what - I'm diversifying by adding more schemes!" But is this how diversification is done? In our opinion just adding schemes just as per the unsystematic advice of your agent / distributor / relationship manager is not "diversification", but in fact "diversity". And as what Mr. Warren Buffet (Chairman of Berkshire Hathaway, U.S. and one of world's richest investor) rightly said, "Wide diversification is only required when investors do not understand what they are doing." So, is it that you investors do not understand what you are doing? If yes, you've got to learn and research more while investing in schemes.

Remember while you diversify, you tend to reduce your risk. But when you "over-diversify", you tend to limit your return on investment. In case of mutual fund schemes, they already are a heaven for diversification, and hence your only job as investors' is to have just the right amount of schemes of different categories (say 1 or 2 under each category), by giving importance to financial planning aspects such as the following:

Age:

Your age should determine which type of mutual fund scheme (whether equity or debt) you should invest. So, if you are young you can allocate a major portion of your investible amount towards, equity schemes and rest towards debt and gold schemes. This is because your tenure of working life is greater, as compared to a person who is nearing retirement. Similarly, if you start early the tenure which you get while investing in an investment avenue is greater, which enables one to make more aggressive investments and create wealth over the long-term to meet your financial goals.

Income

If your income is high, your willingness to take risk is high. This thus can work in your favour, as you have sufficient annual income which allows you to park more money into the equity asset class (through equity mutual fund schemes or stocks), for generating higher returns and creating a good corpus for your financial goal. Similarly, if you aren't earning a high income, but have age on your side (by being young) you may still indulge in equity allocation through the SIP mode in mutual funds which would provide you, the ability to create a corpus to attain your financial goal through power of compounding, and at the same time manage the volatility of the equity markets through rupee-cost averaging.

Nearness to financial goals

While investing if you are earmarking some amount to meet your particular financial goal, then your nearness to that financial goal would also determine how you should allocate your investment, inter as well as intra asset class. So, say you have a financial goal of getting your daughter married well after 20 years from now, with an amount requirement of say Rs 50 lakh, you would require to start with a monthly SIP amount of Rs 3,300 in a mutual fund which offers you return of at least 15% p.a.

Risk Appetite

The term risk appetite refers to your ability to take risk; which is function of your age, income, expenses and nearness to financial goals. So, if your willingness to take risk is high (aggressive), you can skew your portfolio more towards the equity schemes. Similarly, if your willingness to take risk is relatively low (conservative), your portfolio can be skewed towards debt mutual fund schemes or large cap schemes, and if you are a moderate risk taker you can take a mix of 60:40 (into equity and debt respectively) by opting for a balanced fund.

Indicative portfolio category allocation based on risk appetite

Risk Appetite

Aggressive

Moderate

Conservative

Large Cap

Medium

High

High

Mid Cap

High

Low

-

Flexi Cap

Medium

Medium

-

Opportunities

High

-

-

Value

-

Medium

Medium

Balanced

-

Medium

High

Thematic

Low

-

-

Gold ETFs

Very Low

Low

Medium

(Source: PersonalFNResearch)

Please recognise that holding too many mutual fund schemes, with similar objective is not a prudent idea.Also going with star ratings is not a great idea as these stars may lose their sheen during gloomy days of the capital markets. It's okay for business channels and pink papers to disclose star rated funds, as publishing those increases their TRP ratings. The big question which you should be asking yourself is - would my investment portfolio shine like a real "rock star". And if you want it to be dependable (which we believe every prudent investor wants it to be!), your portfolio should constitute of sufficient schemes which can stand by you through health and sickness.

Moreover it is noteworthy that, you just don't need to churn funds from your portfolio, if you have consistently good performing schemes in your portfolio. Churning would just not do any good to you. But sure for your distributor / agent / relationship managers, it would make their dough as they would be earning enticing commissions. Remember, while everyone's there to give advice, what matters is whom you take it from. Think hard on this! Do not let your hard earned money go down the drain for free advice or tips.

Please recognise that buying investment products is not like buying grocery and vegetables - a thorough assessment of your risk appetite and time horizon is vital to determine which mutual fund really fits in your portfolio. In the past if you have found yourself trapped into the clutches of your distributor / agent / relationship manager who's interested in making his own money through hefty commissions and variable pays, it's time that you review your mutual fund portfolio. An effectively drawn portfolio review from a research driven mutual fund expert would help you to assess the following:

Risk-Return

While your distributor / agent / relationship manager may have pushed you schemes just based on their returns, a portfolio review would help you assess the degree of risk which your portfolio is exposed to - whether high, average or low, thereby assessing whether the schemes(s) have justified their risk taken by providing appealing returns.

Moreover if you are holding some junk schemes or bleakly shining star-rated funds, the review would also recommend an action to be taken - whether hold or sell, along with enough reasoning for the same. In fact the performance track record would reveal the same.

Fund categorisation

Apart from the above, a well-drawn mutual fund portfolio review would also categorise your holdings on the basis of the type of schemes held by you (i.e. whether equity, debt or gold) as well as the style of investing followed by them (i.e. whether growth, value and blend) and the market cap bias followed- i.e. large cap, mid cap, small cap, micro cap, flexi cap, multi-cap etc. A vigorous portfolio review would also help you take a call on sector and thematic funds as well, apart from the diversified ones.

Sector classification

As many of you would be interested in knowing, the composition of each sector to your portfolio, a high-quality portfolio review would help you in knowing exactly how much percentage of your total portfolio is skewed towards which sector(s), thereby enabling you to further assess the sector specific risk which you are exposed to.

Top-10 stock holdings

Yes sure, knowing your inquisitiveness to know what would be the stock holdings of your total mutual fund schemes, a full-bodied portfolio review would also provide you top-10 stock holdings of all the schemes in your portfolio. This would help you assess how much percentage, is held by your fund in each stock, thereby giving you a fair idea what the fund managers are betting on.

But remember, all this can be provided by a mutual fund expert, who follows a research driven process to select funds (rather than arbitrary methods), and the one who understands your profile and needs, and accordingly helps you create and manage your mutual fund investments. Similarly, for stocks while there are galore of pink papers and business channels providing recommendations for free, it is vital for you to get an opinion from an expert who gives due weightage to fundamentals of a company, rather than the momentum or so to speak the khabarin the market. Remember betting on the short-term momentum can be dangerous to your wealth as well health. It is only through a disciplined long-term fundamental approach, you can create wealth for you and your family.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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